David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Zhongman Petroleum and Natural Gas Group Corp.,Ltd. (SHSE:603619) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zhongman Petroleum and Natural Gas GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Zhongman Petroleum and Natural Gas GroupLtd had debt of CN¥3.75b, up from CN¥2.54b in one year. However, it does have CN¥2.30b in cash offsetting this, leading to net debt of about CN¥1.45b.

A Look At Zhongman Petroleum and Natural Gas GroupLtd's Liabilities

According to the last reported balance sheet, Zhongman Petroleum and Natural Gas GroupLtd had liabilities of CN¥4.90b due within 12 months, and liabilities of CN¥1.82b due beyond 12 months. Offsetting this, it had CN¥2.30b in cash and CN¥1.13b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.30b.

This deficit isn't so bad because Zhongman Petroleum and Natural Gas GroupLtd is worth CN¥9.17b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhongman Petroleum and Natural Gas GroupLtd has net debt of just 0.91 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.8 times the interest expense over the last year. Fortunately, Zhongman Petroleum and Natural Gas GroupLtd grew its EBIT by 4.5% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhongman Petroleum and Natural Gas GroupLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Zhongman Petroleum and Natural Gas GroupLtd reported free cash flow worth 10% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Even if we have reservations about how easily Zhongman Petroleum and Natural Gas GroupLtd is capable of converting EBIT to free cash flow, its net debt to EBITDA and interest cover make us think feel relatively unconcerned. We think that Zhongman Petroleum and Natural Gas GroupLtd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zhongman Petroleum and Natural Gas GroupLtd has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.